DR GERARD LYONS: We must hike interest rates soon, but do it with baby steps

Dr Gerard Lyons: In my view when rates increase the Bank should raise them in very small steps of 0.125 per cent each time

In recent years savers have suffered and borrowers have benefitted as the UK joined the US and Europe in slashing interest rates to rock bottom levels.

Last Thursday the Bank of England left interest rates unchanged at 0.5 per cent.

They have now been at this level since March 2009, and the last time the UK base interest rate increased was in July 2007, when it rose by 0.25 per cent to its last peak at 5.75 per cent.

It may now not be long before the base interest rate rises again, with a hike probable later this year.

The
economy is recovering, but from a low level. Indeed it is only now back
to the level it was before the crisis. The good news is that there is
momentum. The challenge is that there is still too much debt: personal
as well as government.

It
is for this reason that the Governor of the Bank of England has
continued to say that interest rates will stay low, they will increase
gradually and peak at a low level.

I
agree that we need to be careful about when and by how much we should
raise rates. It is possible that some people and businesses may be hurt
by even a small increase.

Dr Gerard Lyons is chief economic
advisor to Boris Johnson. His new book ‘The Consolations of Economics’
is published by Faber & Faber.

For many people they need to see wages rising and firms need higher demand before they are able to cope.

Moreover, in recent months the Bank of England has been making use of its new powers to take the heat out of the housing market.

The combination of new macro-prudential measures and the mortgage market review is aimed at making banks think twice about how much they lend and who to.

It may make sense for the Bank of England to be sure how these measures are working before they raise rates.

In my view when rates increase the Bank should raise them in very small steps of 0.125 per cent each time.

Such gradual increases would allow monetary policy to be tightened in a way that allows the economy to cope.

The challenge is also greater now because of the way policies have been set.

As I outline in my new book ‘The consolations of economics’, policy has moved in recent years from the three T’s to the three S’s to the three U’s!

Before the 2008 financial crisis, monetary policy in America was referred to as the three T’s: being timely, targeted and temporary. It was an apt analogy that fitted well what was also happening in the UK.

Then the crisis hit and Western economics acted in unison. Policy became the three S’s: synchronised, sizeable and successful.

Synchronised as countries acted together.

Unchanged: The Bank of England left UK interest on hold at 0.5 per cent

Sizeable because the policy boost was huge as the UK, Europe and US threw everything including the kitchen sink at the problem. It worked in the sense that it prevented depression, but as you might expect it left a mess.

Hence in recent years monetary policy had to be used aggressively, evolving into the three U’s: unlimited, unclear and unknown.

Unlimited in terms of the amounts being played with, as the Bank of England along with other central banks pumped in huge amounts of money.

Unclear as to how successful this policy has been, because success has been hard to measure.

And unknown, both in terms of the longer-term repercussions of keeping interest rates so low for so long and in how to exit easily from such a policy.

It has made sense not to raise interest rates up to now. Premature tightening could have derailed recovery.

Now the danger is the economy becomes dependent upon low interest rates and hence the need to now consider hiking later this year, but only gradually and slowly, in baby steps.